Monday, February 25, 2008

The Definition of Stagflation

Currently people throw the word “stagflation” around a lot so it is a good idea to define the term. At this time the US runs a serious risk of sliding into a period of stagflation. Slow growth caused by the housing problems, credit crunch, slower consumer demand, etc.; monetary and fiscal polices that are trying to stimulate the economy out of a recession; and higher energy and commodity prices all lead to a potential period of stagflation. The ultimate problem with stagflation is that it is hard to get out of. This definition came from If you don't like this one there are plenty of others to choose from.

Term coined by economists in the 1970s to describe the previously unprecedented combination of slow economic growth and high unemployment (stagnation) with rising prices (inflation). The principal factor was the fourfold increase in oil prices imposed by the Organization of Petroleum Exporting Countries (OPEC) cartel in 1973-74, which raised price levels throughout the economy while further slowing economic growth. As is characteristic of stagflation, fiscal and monetary policies aimed at stimulating the economy and reducing unemployment only exacerbated the inflationary effects.

A meatier definition and discussion can be found at Wikipedia:

Stagflation, a blend of the words stagnation and inflation, is a macroeconomics term used to describe a period of inflation combined with stagnation (that is, slow economic growth and risingunemployment, possibly including recession). The term stagflation is generally attributed to United Kingdom Chancellor of the Exchequer Iain MacLeod, who coined the term in a speech to Parliament in 1965.

Stagflation came to be recognized as a potentially important macroeconomic problem in the 1970s, when it afflicted many countries in the developed and developing world. Prior to the 1970s, the prevailing Keynesian school of macroeconomics assumed that inflation and stagnation were unlikely to occur together. Macroeconomists at that time believed that stagnation could typically be cured by expansionary monetary or fiscal policies, while inflation could be cured by contractionary monetary or fiscal policies. When both stagnation and inflation occurred at the same time, this called into question existing macroeconomic theories and also posed a dilemma for the standard policy remedies that had been used to stabilize the economy in the past.

Economists today typically offer two main explanations of stagflation. First, stagflation can occur when an economy is slowed by an unfavorable supply shock, such as an increase in the price of oil in an oil importing country, which tends to raise prices at the same time that it slows the economy by making production less profitable.
Second, both stagnation (recession) and inflation can be caused by inappropriate macroeconomic policies. For example, central banks can cause inflation by permitting excessive growth of the money supply, and the government can cause stagnation by excessive regulation of goods markets and labor markets. The global stagflation of the 1970s is often blamed on both causes: it was largely started by a huge rise in oil prices, but then continued as central banks used excessively stimulative monetary policy to try to avoid the resulting recession (stagnation), causing a runaway wage-price spiral.

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